INVESTORS HAVE SEVERAL CHOICES WHEN CONFRONTED WITH THE BUBBLE

The Chinese economy, London’s real estate, social media companies, Tesla Motors. What is it with all people calling everything a bubble these days?

There are a thousand definitions for a bubble. Some say it is a huge trend you have not participated in. Others stick to a more conventional description — unsustainable valuation.

One of the purposes of free markets is to correct excesses. If you believe that something is a bubble, devise a plan to profit from it. Don’t just stay on the sidelines. There are several ways to participate:

1) You could become part of the momentum and help early short sellers to part with their money. George Soros loves bubbles: “When I see a bubble, I buy that bubble, because that’s how I make money.”

2) If momentum is not your forte, then short it and see where it gets you. Just because something seems overly expensive, it does not mean that it won’t become more expensive. Hundreds of money managers thought that the housing market in the U.S. was in a bubble in 2004. They ended up being right, but between 2004 and 2006, many homebuilders’ stocks quadrupled in value. You cannot afford to lose 300 percent of your clients’ money. Most will take it back, when you’re down 30 percent, so even if you end up being right, you might not even be able to benefit from it.

3) Wait for the bubble to bust and pick up the pieces at extremely low prices and sell them during the next bubble. Here’s the thing. You need leverage to create a bubble. Financial leverage. Leverage is the main reason why when a bubble bursts, the market overshoots to the downside and sends asset prices to extremely low prices. Without a big bubble, you cannot have a big bust. And without a big bust, you cannot pick up assets at extremely attractive valuations.

Most people take the passive approach of sidelined viewers. Everyone has an opinion, but very few have an idea how to turn that opinion into an actionable plan. It is the trading and investing ideas that matter.

If you believe that something is a bubble, you could actually profit from it. Usually, people who point fingers and call something a bubble do it for one main reason — to declare to the world that they will never put their money there and other people should do the same, because “it will end badly.” And you know what? Maybe it will. The financial history is full of booms and busts and actually both precipitate each other. Learn to live with it. Bubbles are not going anywhere. Neither are busts. But you could make a big difference in your life if you learn how to participate in them.